Wednesday, October 31, 2012

Consider this eccentric interpretation of spot trades by an Austrian over at Robert Murphy’s blog:

“All ‘spot’ trades are actually credit (i.e. trusting the counter-party to make good on their end of the exchange) exchanges. The only difference is the length of time it takes to finalize an exchange.”

To see why, let us start with sale and purchase contracts. A sale and purchase exchange (what was called emptio venditio or emptio et venditio in Roman law) is a contract by which a seller (vendor) transfers ownership or title to property rights of a good or goods to a buyer (emptor) for a money price. The essence of the exchange is transfer of ownership in exchange for money, and the sale and purchase agreement can be made by parties at a distance: that is, by message, by letter, or by legal agents. The buyer and seller do not stand to one another as a creditor and debtor do.

An absolute sale, for example, is a sale where title to property passes to the buyer simply with the payment of price to the seller and mutual agreement (if transfer of ownership takes place at a future date, there is an “agreement to sell” contract). Transfer of ownership can become effective when a sale and purchase agreement contract is made.

The essential nature of the sale and purchase agreement can be seen when contrasted with a sale on credit: here the property rights to the thing sold only pass to the buyer when he has made the final payment of the price (and hence repayment of his debt). In the latter contract, there really is a credit–debt relationship. In the sale and purchase exchange, there is no such credit–debt relation. In the absence of transfer of ownership, we have no sale or purchase contract, but hire, leasing, or credit/debt exchanges.

Delivery is not even a necessary condition for the title to property to pass from a seller or buyer. It is possible for a buyer to purchase a good and allow the seller to hold it as a bailee. If the seller/bailee does not later deliver the good to the buyer on demand, then the bailee could be guilty of theft (a criminal offence). By contrast, the failure of a debtor to repay debt is not theft, but merely breach of contact (a civil law offence).

Now we come to barter spot trades. Barter spot trades are direct exchange of one commodity for another, in an exchange where the things exchanged are agreed upon and accepted by both parties. The exchange is very much like the sale and purchase contract, except that it is another good that is the exchanged for another, rather than money. The essence of the barter spot trade, when goods exchange for goods, is also transfer of ownership or title to property rights between the parties, but in this case mutual exchange of ownership of goods. The exchange does not create

When a barter spot trade occurs, ownership of the object for which you have exchanged your own good(s) passes to you by agreement. Having no time period between the original agreement and the delivery of the new good you have bartered for is not a defining characteristic of the spot trade: indeed, although two parties could in theory exchange two commodities at the same time, in practice time usually does occur between handing over of one commodity and giving of another. It is perfectly true that there may be 1 second, 10 seconds, 30 seconds, 1 minute, 5 minutes, a few days or even weeks between the spot trade agreement and actual delivery or receipt of the goods or one of the goods. Yet by agreement the two parties have already exchanged property rights or title to property: actual possession of a good is different from ownership. Once ownership or title to property has passed there is no credit/debt relationship.

As we have seen, with money we have sale and purchase agreements, not credit transactions. The time element between purchase of the good and actual delivery is again not the key or defining characteristic of the sale and purchase agreement. Again, it is perfectly true there may be 1 second, 10 seconds, 30 seconds, 1 minute, 5 minutes, a few days or even weeks between the purchase of the good from the vendor and actual deliver or receipt of goods. But that is irrelevant. The crucial concept is ownership. The seller has no debt to the buyer, even if a short time might pass before actual delivery occurs. The time element is nothing but a red herring. The seller merely has a legal obligation to deliver the property, once bought.

A debt/credit relationship, by contrast, is one where a person lends a good (or money) as a mutuum to a debtor. He is obliged to return, not the same good (or money), but a good of equivalent value or quality. This is not a sale-purchase agreement or barter spot transaction where specific goods are sold or exchanged. A debt/credit relation means that the debtor owes an agreed upon price or value to the creditor.

Also, in a debt/credit exchange based on gift exchange, many “creditors” or parties in gift exchange have not even yet decided what they want back from their “debtor.” They will call in their debt at some point in the future, and the debtor may not even know what will be demanded. The debtor does not hold some good already owned (or bought) by a purchaser. He remains merely in debt to the creditor for an agreed upon debt defined as a certain value.

Sunday, October 28, 2012

In the socialist economic calculation debate (Mises 1935 [1920]), Mises argued that “rational economic calculation” was impossible in a planned, command economy, because the lack of market prices for capital goods eliminated those markets which produce prices for the means of production, and capitalists need these prices to calculate profit and loss.

But what is most curious is Mises’s view of a syndicalist economy (see Mises 1924 and 2002):

“ … [sc. Mises found] Polanyi’s concept of … [sc. syndicalism] as nebulous as that of the Guild Socialists. The ‘body politic’ is to be the ‘owner’ of the means of production, but it does not have the right of use (‘usus’) over them. That is reserved for the producers ‘association’; chosen by the workers on a sectoral basis. This ownership arrangement resembles the Yugoslav property system.

Von Mises considers the basic flaw of this construction to be the vagueness by which it seeks to evade a crucial question: Is the system supposed to be socialist or syndicalist? Polanyi first assigns the means of production to society as a whole, the ‘commune’; and thus seeks to absolve himself from the charge of ‘syndicalism’ (which must have been quite a crime among Austrian Marxists in the early 1920s) But von Mises states, ‘Property is the right of use, and if that is assigned to the production associations, then these are the owners and then we are dealing with a syndicalist society’ (N.B., p. 491). A choice must be made: there can be no reconciliation between socialism and syndicalism. This strict distinction between the two (which von Mises had in common with all Marxist socialists of the time – and perhaps of today), he made on the basis of a theory of property rights. Property rights over the means of production must be assigned to some concrete body: if neither the ‘commune’ nor the production associations have the final say in their allocation, then the system is not viable. If final decision-making power rests with the commune (the political organization of the community), then one is dealing with a ‘zentrale Verwaltungswirtschaff’; a centrally administered economy such as Soviet Russia’s. Polanyi agrees that rational economic calculation is impossible here. If the final power rests with the production associations, then there exists a syndicalist commonwealth.

Polanyi’s confusion on this point make him suggest a pseudosolution to von Mises’s problem. His associations engage in mutual exchange relations, they give and receive as if they were the owners of the goods, and thus a market and market prices are created. Polanyi does not notice that this is irreconcilable with the essence of socialism, von Mises agrees that rational economic calculation is possible under syndicalism or under any other producer cooperative-based system where the cooperative bodies are the owners of the means of production. Thus, there is some kind of group-collective private ownership, what the Maoists during the Chinese cultural revolution used to criticise as Yugoslav group-capitalism. Group-capitalism is also capitalism and allows rational calculation.” (Keizer 1987: 113–114).

Mises’s ideas have some interesting consequences: a syndicalist system where “associations engage in mutual exchange relations, [sc. and where] they give and receive as if they were the owners of the goods” would actually be a certain type of capitalist system!

Such a syndicalist system would, then, be perfectly capable of engaging in rational economic calculation.

It also has another consequence: a capitalist economy merely with Keynesian macroeconomic management is also free from the original and strict “economic calculation” problem defined by Mises: lack of market prices for capital goods eliminating producers’ goods markets needed by capitalists to calculate profit and loss.

A capitalist system with Keynesian policy is an economy where the overwhelming, vast majority of capital goods are owned, produced and sold privately on markets, and the vast majority of all production is private. As in a syndicalist system, it would be free from Mises’s original economic calculation problem.

I say this because confused internet Austrians are both ignorant and clueless on this issue. Time and again, these vulgar Austrians wave the original socialist economic calculation debate around as if it constitutes a serious argument against Keynesian economics.

The Austrian argument against Keynesian economics on the basis of alleged “economic calculation or miscalculation” problems involves quite different issues, as follows:

(1) the alleged miscalculation problems caused in the Austrian business cycle theory (ABCT) (or what other Austrians refer to as the “theory of intertemporal discoordination”). The ABCT is one of economic miscalculation and malinvestment. The ABCT is one part within the broader Austrian theory of economic coordination and discoordination, but it remains a flawed and false theory.

(2) the assertion that government spending, or other interventions, causes price distortions. Yet virtually all spending can potentially cause “price distortions” from what they would otherwise have been. Whatever “distortion” government causes is no more or less severe than what the private sector itself imposes. For example, it is absurd to believe that the millions of agents offering goods and services get their prices right in terms of demand/supply dynamics. Many corporations and business are in fact price setters/administrators: they set their prices according to production costs and then a profit markup, then leave them unchanged for significant periods of time, even when demand changes. The prices are not fundamentally set by supply/demand dynamics at all: they are set by central planners in corporations. A market economy at any one moment has a vast number of “wrong” prices. But this does not mean that the market collapses: it still achieves investment, production and economic growth over long periods.

Supposedly, government deficit spending, price controls, subsidies, income policies, and so on, will also impair economic calculation on the market by impairing prices, presumably in some disastrous, destabilising way. But it is not difficult to see how the Austrians have a view here that sees the market as ridiculously feeble. For example, does the existence of some minor government subsidies cause an Austrian trade cycle? Would they impair the ability of the private sector to engage in production of commodities with rising real output? Would they distort the market so badly that nobody could engage in “economic calculation”?

The idea that the normal types of government spending cause some severe problems of “economic calculation” leading to market chaos is patent nonsense. The alleged price “distortions,” either public or private, don’t cripple capitalist economies, and it is doubtful whether they are harmful at all, in the way imagined by Austrians. They don’t prevent vast and successful private production of wealth and investment. In the case of price setting, the empirical literature suggests that it has benefits they outweigh costs: stability of profits and the prevention of disastrous price wars between businesses, for example.

The primary cause of the appearance of extensive unemployment, however, is a deviation of the actual structure of prices and wages from its equilibrium structure. Remember, please: that is the crucial concept. The point I want to make is that this equilibrium structure of prices is something which we cannot know beforehand because the only way to discover it is to give the market free play; by definition, therefore, the divergence of actual prices from the equilibrium structure is something that can never be statistically measured.” (Hayek 1975: 6–7).

Yet the central concept here is nothing but the notion of a tendency to a price vector that will clear all markets (with flexible wages clearing the labour market). This is not an “Austrian” idea at all: it is a Walrasian or neo-Walrasian neoclassical idea, straight from general equilibrium theory. The Austrians did not invent this, but simply borrowed it from Walrasian neoclassicals.

Anyone who denies that markets have a real world tendency to general equilibrium can easily refute this argument: for the notion that markets are coordinated in this way at all is nothing but a myth.

Friday, October 26, 2012

This is where Fisher expounded his theory of debt deflation, or at least the paper people generally cite.

Yet it was not in fact Fisher’s first statement of the idea. Fisher’s theory was first stated in his Yale lectures in 1931, and then in a talk before the American Association for the Advancement of Science on 1 January 1932 (Fisher 1933: 350, n.). It was then published in his book Booms and Depressions: Some First Principles (London, 1933).

Even Fisher admitted that Thorstein Veblen’s book The Theory of Business Enterprise (in chapter 7) came close to a prior debt deflation theory (Fisher 1933: 350, n.).

Fisher also mentions Ralph Hawtrey and Frederic L. Paxson (University of Wisconsin) as other forerunners of the debt deflation idea, though their theories were far from complete, and Fisher still claimed a degree of originality and sophistication not seen in earlier theories (Fisher 1933: 350, n.).

Fisher viewed business cycles as caused by many factors or forces, both exogenous and endogenous (Fisher 1933: 338). It is noticeable that Fisher had still not completely freed himself from general equilibrium theory, even in his 1933 paper, for he could write the following:

“We may tentatively assume that, ordinarily and within wide limits, all, or almost all, economic variables tend, in a general way, toward a stable equilibrium.” (Fisher 1933: 339).

Nevertheless, it “is as absurd to assume that, for any long period of time, the variables in the economic organization, or any part of them, will ‘stay put,’ in perfect equilibrium, as to assume that the Atlantic Ocean can ever be without a wave” (Fisher 1933: 339).

Fisher rejects Say’s law and accepts that general overproduction at certain times is a reality (Fisher 1933: 340).

Fisher saw two factors as playing a major role in the business cycle: (1) over-indebtedness and (2) deflation “following soon afterwards,” and regarded the economic crises of 1837, 1873 and 1929–1933 as important examples of debt deflationary episodes (Fisher 1933: 341). The excessive debt may cause over-investment and over-speculation in the boom (Fisher 1933: 341).

According to Fisher we have the following steps in a debt deflationary crisis:

“(1) Debt liquidation leads to distress selling and to
(2) Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes
(3) A fall in the level of prices, in other words, a swelling of the dollar [that is, price deflation – LK]. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be
(4) A still greater fall in the net worths of business, precipitating bankruptcies and
(5) A like fall in profits, which in a ‘capitalistic,’ that is, a private-profit society, leads the concerns which are running at a loss to make
(6) A reduction in output, in trade and in employment of labor. These losses, bankruptcies, and unemployment, lead to
(7) Pessimism and loss of confidence, which in turn lead to
(8) Hoarding and slowing down still more the velocity of circulation.

The above eight changes cause (9) Complicated disturbances in the rates of interest, in particular, a fall in the nominal, or money, rates and a rise in the real, or commodity, rates of interest.” (Fisher 1933: 342).

This description is of course a model, and in real life the order, intensity, effects and interrelations of the factors above may be different in any actual recession or depression (Fisher 1933: 342 and 344).

Fisher was also quite clear that deflation alone in an environment without great private debt does not necessarily cause economic disaster:

“Likewise, when a deflation occurs from other than debt causes and without any great volume of debt, the resulting evils are much less. It is the combination of both-the debt disease coming first, then precipitating the dollar disease-which works the greatest havoc.” (Fisher 1933: 344).

By the end of the paper, Fisher turns to solutions to debt deflation, and his cure is “reflation” or price stabilisation (Fisher 1933: 346–348), a cure he appears to think can be achieved mainly by monetary policy. We see here how Fisher wrote before the Keynesian revolution and the turn to the importance of fiscal policy.

BIBLIOGRAPHY
Fisher, Irving. 1933. Booms and Depressions: Some First Principles. George Allen and Unwin, London.

I began reading this paper and at first remained quite disappointed, for Lachmann (on p. 302) about halfway through his discussion declares that his “attempt to establish a causal relationship between Uncertainty [sic] and liquidity-preference has so far turned out to be a complete failure.”

After this, the paper improves. If uncertainty is defined as the anxiety of the debtor whose debt is due on demand, then uncertainty, says Lachmann, can be the cause of liquidity preference (Lachmann 1937: 302).

Money has as a medium of exchange an indirect utility derived from the goods it can purchase (Lachmann 1937: 303).

Then the following interesting analysis occurs:

“In other respects Money yields direct satisfaction, e.g., in its function of a store of value. But we have already seen that in this respect it has almost as many substitutes as there are (non-perishable) goods, and that it is impossible to predict when it will be used as store of value and when something else. Sometimes the satisfaction derived from its possession will be even more ‘direct’. Moliere’s Harpagon, e.g., derives as much ‘direct satisfaction’ from the contemplation of his hoarded treasures as does the spectator from seeing him on the stage.” (Lachmann 1937: 303–304).

So here we see that the notion that money yields direct utility is not unknown in Austrian economics, and was proposed as early as 1937 by Lachmann.

Lachmann also notes how, in the world of business, demand for money for investment and other business activity essentially means demand for credit, and that many businesses can obtain that credit via negotiable debt instruments, and not high-powered money directly (Lachmann 1937: 306) – which anticipates endogenous money theory.

Lachmann concludes that uncertainty is the cause of liquidity preference (Lachmann 1937: 306).

Postscript
It is a pity that the final two pages of the article (Lachmann 1937: 307–308), where Lachmann discusses liquidity preference and the trade cycle, are disappointing, in that Lachmann’s proposal for dealing with increased liquidity preferences of banks during a recession/depression is to compel “immediate reconstruction [sc. of banks] after the outbreak of a crisis” and to “enforce the early closing of all banks” where reconstruction is not possible (Lachmann 1937: 308). While quick bank “reconstruction” is all well and good, it does not follow that insolvent banks must close (which, I assume, requires mass loss of the money of depositors?). The latter would just exacerbate the crisis.

It was once claimed by Murray Rothbard that deflation was the natural state of the economy: or, that is to say, what Rothbard imagined as the “natural state” in his anarcho-capitalist fantasy world.

Needless to say, anarcho-capitalism has never existed in the real world, so we really have no empirical evidence to support such an idea. If we turn to the real world, the most laissez faire economy ever seen in the US (relatively speaking) was certain periods during the gold standard era. Austrians are fixated on the 1873–1896 period because of the near continuous price deflation in that time, but the truth is that it was an historical aberration.

A look at the data on price inflation in the US shows that inflation regularly occurred in the late 18th and 19th centuries:

If we ignore those periods of war such as the American War of Independence (1775–1783), the War of 1812 (or Anglo-American War from 1812–1815), and the Civil War (1861–1865), we still find many periods of price inflation, usually when booms were occurring (that is, expansions in the business cycle).

Even in the 19th-century, gold-standard era, booms were basically inflationary (outside of the historically aberrant 1873–1896 period). For example, the US had price inflation under the gold standard in the following booms: 1825, 1834–1837, 1844–1847, 1841, 1852–1855, 1857, 1859, 1880, and 1896–1914. In particular, there was a period of protracted price inflation in most Western nations from 1896–1914. And note that the United States had no central bank for most of this period.

It is interesting to compare the periods of deflation above with those periods when the US suffered recessions in the 19th century, on the basis of Davis’s list from real manufacturing output data:

Although there is not a perfect match, it nevertheless seems to me that many of these recessions were deflationary periods as well: this tends to confirm that, before the unusual period of deflation from 1873 to 1896, people tended to think of strong booms as inflationary and recessions as deflationary.

Thus when Irving Fisher wrote this in 1933, he could have cited some considerable evidence in US history to support it:

“I had since 1909 been stressing the fact that deflation tended toward depression and inflation toward a boom.” (Fisher 1933: 350, n.).

And that is how many economists have come to see the nature of deflation too.

BIBLIOGRAPHY

Davis, J. H. 2006. “An Improved Annual Chronology of U.S. Business Cycles since the 1790s,” Journal of Economic History 66.1: 103–121.

Thursday, October 25, 2012

The idea that money only has utility through its exchange value – or, that is to say, money’s indirect utility is derived from the utility of any commodity or set of possible commodities you can purchase with it – is held by Austrians and, as far as I can see, neoclassicals.

This view is wrong: for money can yield direct utility (Graziani 2003: 11).

Money or even highly liquid financial assets (like deposit-insured bank deposits) can provide direct utility by diminishing the fear or worry we experience from the uncertainty that we won’t be able to meet our liabilities or obligations in the future.

One can compare the direct utility that money delivers with the utility provided by a fire alarm: imagine you buy a fire alarm and install it correctly in your home. You may never have a fire in your whole life, and the fire alarm may never in fact go off. Yet the ownership of a working fire alarm nevertheless provides direct utility: it gives you satisfaction or pleasure in diminishing your fears that a fire may occur at night in your house without your knowing or waking up in time. Money’s direct utility works in the same way: it diminishes our fear about the future. Those fears could be manifold: unexpected income loss or money problems from losing our job, accident, sickness, or unexpected future liabilities or obligations.

One of the consequences of recognising that money has direct utility is that the regression theorem – touted by Austrians as the great achievement of their hero Mises (2009 [1953]: 108–111, 121) – becomes entirely otiose.

The whole assumption underlying the regression theorem – that money only has indirect utility – is flawed.

According to Mises, the objective exchange-value of money is “popularly called its purchasing power” (Mises 2009 [1953]: 97). Money is held by people in cash balances, but not to be consumed: money (supposedly) has no use in itself, but is held because of its past exchange value, so that it may be exchanged for goods (Rothbard 2011: 692). What is the cause of the immediate future purchasing power of money? Mises held that the solution is to look at the purchasing power of money in the immediate past (Mises 1998 [1949]: 405). However, there is a problem with this: it appears that the indirect utility of money (by means of its purchasing power) simply depends on its utility (see Graziani 2003: 7–9). The regression theorem was intended to break this circularity.

But the problem that the regression theorem tries to solve – the alleged circularity involved – is nothing but a pseudo-problem. It follows that the regression theorem is essentially pointless and worthless.

What is strange here is that one can find some Austrians who admit that money can yield direct utility (cf. Hutt 1956, although still not exactly an example of this). In particular, one can refer to this talk by Hans-Hermann Hoppe:

“Because money can be employed for the instant satisfaction of the widest range of possible needs, it provides its owner with the best humanly possible protection against uncertainty. In holding money, its owner gains in the satisfaction of being able to meet instantly, as they unpredictably arise, the widest range of future contingencies. The investment in cash balances is an investment contra the (subjectively felt) aversion to uncertainty. A larger cash balance brings more relief from uncertainty aversion. .... The marginal utility of the added cash is higher than (ranks above) the marginal utility of the nonmoney goods sold or unbought.”Hans-Hermann Hoppe, “‘The Yield from Money Held’ Reconsidered,” Mises Daily, 14 May, 2009, http://mises.org/daily/3449

This can only mean money can provide direct utility as a protection/security against uncertainty.

But Hoppe never thinks about where that leaves the regression theorem.

If it is admitted that money can yield direct utility, then Mises’s whole purpose in thinking up the regression theorem was a waste of time: the imagined circularity he was attempting to solve was an illusion.

I will end by posting the video of Hans-Hermann Hoppe’s talk “‘The Yield from Money Held’ Reconsidered” (delivered at the Prague Conference on Political Economy, 24 April, 2009), with some points following.

First, Hoppe does not refute the quotation of Keynes he cites early in his lecture. For the assertion that the failure to spend money today is likely to diminish consumption and capital goods investments (that is, the increased holding of money is “unproductive” in this sense) is not refuted by invoking the direct utility of money. For the individual, there is no doubt direct utility to be had by holding extra money from the fear of an uncertain future: as Hoppe argues, it can be “productive of human welfare” in this individual or microeconomic sense. But at the aggregate level the effects on production and employment are deleterious. It is the failure to separate micro from macroeconomic effects that destroys Hoppe’s arguments.

And, by the time we get to the end of the talk, Hoppe has long since moved into a la-la land of pure fantasy:

“The situation does not change if there is a general increase in the demand for money, i.e., if all or most people try to increase their cash holdings, in response to heightened uncertainty. With the total quantity of money given, the average size of cash holdings cannot increase, of course. Nor is the total quantity of producer and consumer goods that make up the physical production structure affected by a general increase in the demand for money. It remains unchanged.

In the real world, of course, prices and wages are generally inflexible, or not flexible to a high degree. Exceptions occur in times of extreme economic crisis when deflation and wage deflation can happen. But, in this case, debt deflation will cripple an economy and equilibrating forces will not work.

However, in pointing to the direct utility of money, Hoppe inadvertently and in a paradoxical way actually confirms Keynesian theory in this lecture.

(1) Lerner begins by pointing out that private debt is different from government debt (Lerner 1948: 255–256). In an aggregate sense, government debt is owed by citizens of a nation to other citizens of that nation. That idea is summed up in the phrase “we owe it to ourselves” (Lerner 1948: 256).

Lerner disposes early on of the “debt burdens our children” argument:

“A variant of the false analogy is the declaration that national debt puts an unfair burden on our children, who are thereby made to pay for our extravagances. Very few economists need to be reminded that if our children or grandchildren repay some of the national debt these payments will be made to our children or grandchildren and to nobody else. Taking them altogether they will no more be impoverished by making the repayments than they will be enriched by receiving them.” (Lerner 1948: 256).

“In attempts to discredit the argument that we owe the national debt to ourselves it is often pointed out that the ‘we’ does not consist of the same people as the ‘ourselves’. The benefits from interest payments on the national debt do not accrue to every individual in exactly the same degree as the damage done to him by the additional taxes made necessary. That is why it is not possible to repudiate the whole national debt without hurting anybody. While this is undoubtedly true, all it means is that some people will be better off and some people will be worse off. Such a redistribution of wealth is involved in every significant happening in our closely interrelated economy, in every invention or discovery or act of enterprise. If there is some good general reason for incurring debt, the redistribution can be ignored because we have no more reason for supposing that the new distribution is worse than the old one than for assuming the opposite. That the distribution will be different is no more an argument against national debt than it is an argument in favor of it.

8. The growth of national debt may not only make some people richer and some people poorer, but may increase the inequality of distribution. This is because richer people can buy more government bonds and so get more of the interest payments without incurring a proportionately heavier burden of the taxes. Most people would agree that this is bad. But it is no necessary effect of an increasing national debt. If the additional taxes are more progressive — more concentrated on the rich — than the additional holdings of government bonds, the effect will be to diminish the inequality of income and wealth.” (Lerner 1948: 260–261).

By contrast, debt owed to foreigners can be considered a burden (Lerner 1948: 256), because the debt is external, and to the extent that real goods and services will be demanded by foreigners, this is a real cost.

(2) Lerner addresses the idea that, if taxes are raised to pay for interest payments on the debt, this might have a contractionary effect. While this might be true, Lerner points out that there is no reason why the government need raise taxes to meet its obligations in paying debt, if contractionary fiscal policy is not desired: the reality is that government can simply “roll over” debt with more borrowing (Lerner 1948: 258–259).

When Murphy and others have argued that government debt can “burden” future generations all they appear to mean is that taxes at that future point in time will transfer income from some people then to others then. This is actually nothing more or less than saying that government debt paid back in the future merely represents a redistribution of wealth then.

Murphy has not proven:

(1) that the aggregate level of private investment or consumption in the future will be reduced by deficit spending now;(2) that the capital stock in the future will be reduced by government deficits now, or(3) that present generations are somehow “robbing” future generations.

I repeat what I have said before: the notion of present generations “living at the expense of future generations” is utter nonsense. Any future generation cannot send real goods and services, money or assets back in time, and our wealth today is dependent on the real goods and services produced, owned and consumed today, not in the future. The repayment of future government debt comes from three sources:

(1) Central bank open market operations. This does not even involve taxpayers’ money at all: money used to pay back debt in this way is simply created by central banks.

(2) The government has the power to roll over much of its debt. As long as people keep purchasing the debt, there’s no problem.

(3) The government’s repayment might be from current tax revenues. But, with expanding GDP, the government has access to tax receipts which grow over time, which effectively means that the burden of interest servicing and paying back debt falls as the population rises, GDP grows and tax revenues rise. Since the US has a progressive tax system the “individual” burden of government debt repayment differs markedly depending on income anyway.

The future “individual” burden of government debt is simply a redistribution of money at a future time point or period, and, if the money is spent, a redistribution of real goods, services or assets within the society at some future point in time: it cannot be a robbery by present generations of future wealth, because there is no way that future, real goods and services can be magically transported back in time to today.

The chief reason cited for the alleged “success” by Shostak is the fall in the unemployment rate in Estonia. Shostak asserts that unemployment “fell to 5.9 percent in August from 7.6 percent in January.” I am not sure where he gets his figures from.

According to Tradingeconomics.com, unemployment in Estonia in the second quarter of 2012 was at 10.2%. In late 2011, it was at about 11%:

Now it is certainly true that Estonian unemployment significantly fell from 2010 to early 2011 (from about 20% to 13%). But why did unemployment fall like this? The evidence suggests that a great deal of the fall in unemployment in these Baltic states in the years of austerity should be ascribed to mass emigration, not to strong domestic employment growth:

“… all three [sc. Baltic states] have seen mass emigration over the last four years, particularly amongst the young. All three have the highest emigration rates in the EU, with 24 people out of every 1,000 leaving Lithuania in the last year. This, in turn, has restrained domestic unemployment; and while people should be free to go and find work where they can, their exit hardly counts as a ringing endorsement for the government.” James Meadway, “The Myth of Successful Baltic Austerity,” New Economics Foundation, 18 July 2012.

And then we get this astonishing admission from Shostak:

“Since Q2 2011 the government has reversed its stance and embarked on massive spending. The average of the yearly rate of growth between Q2 2011 and Q2 2012 stood at a positive figure of 11 percent. (Contrast this with the -7.4 percent during Q3 2009 to Q1 2011.) Furthermore, the yearly rate of growth of money supply has been displaying strong growth. The average of the yearly rate of growth between December 2009 and August 2012 stood at 8 percent. (Contrast this with the figure of -7.9 percent during May 2008 to November 2009.) Rather than persisting with the cleansing process, the government and the central bank have chosen to reverse the stance, thereby arresting the process of healing the economy.” Frank Shostak, “Why Estonia Is Beating the Eurozone,” Mises Daily, October 18, 2012.
http://mises.org/daily/6232/Why-Estonia-Is-Beating-the-Eurozone

So in truth Estonia has from quarter 2, 2011 embarked on fiscal expansion to some degree (just how significant I don’t know, without further research).

That fiscal expansion is correlated with the higher GDP growth rates that occurred from 2011:

So whatever one wants to argue about the strong growth rates and recovery from 2011 (which was probably due to export-led growth to some degree as well), it was not correlated with austerity at that time.

In general, if your model of economic policy is to drive a significant proportion of the population overseas, owing to the social devastation caused by domestic wage and price deflation (what seems to have happened in the Baltic states from 2008–2011), then no doubt you can declare a “success” story.

Those of us not in thrall to neoclassical or Austrian economics will not be convinced or impressed by such balderdash, however.

Monday, October 15, 2012

Consider the following correspondence between Keynes and Hayek that occurred in late 1931 and early 1932 on Prices and Production (1931):

To F. A. HAYEK, 25 December 1931

That is what I thought you meant and that is just my difficulty. For by the ‘effective circulation M’ in your first letter of Dec. 15 you seemed, judging by the context, to mean something which corresponded in some sense to what one might call ‘aggregate income’, which is not the same thing as aggregate money turnover. If M means money turnover, why must ‘a certain proportion pM be constantly reinvested in order to maintain the existing capital constant'? I am not able to perceive any particular relation between aggregate money turnover and the amount of capital replenishment required to keep capital constant.

J.M.K.

___________

From F. A. HAYEK, 7 January 1932

Dear Keynes,
Returning from the meeting in Reading and a few days stay in [the] country I find your letter of December 25th. The question which you put in it is, indeed, of the most central importance and if I had thought that you had any difficulties about this point I should have long ago tried to make it clearer. When, however, you wrote on p. 397 of your Economica article that you consider the replacement of ‘disinvestment’ as ‘investment’ I thought you saw the point.

If we take a stationary society where there is no saving and no net investment (in your sense) a constant process of reproduction of existing capital will go on which is necessary in order to maintain its amount constant. In the case of circulating capital this will mean that its total amount will have to be replaced at least once during every year, and in the case of fixed capital that a certain proportion of the total existing capital which wears out during each year will have to be replaced. If we take the simplest case to which I have unfortunately confined myself too much in Price[s] and Production, i.e. the case where, all the existing capital owes its existence to one of the reasons which make the existence of capital necessary, namely to the duration of the process of production—the other cause being the durability of many instruments of production—and where, therefore all capital is ‘circulating capital’ in the usual sense of this word—which is very misleading because this circulating capital is different from fixed capital only from the point of view of an individual and not for society as a whole—it is fairly clear that a continuous process of production requires in every stage a constant disinvestment and reinvestment so that, if we assume that goods pass from one stage of production to the next every period of time, there will be a constant stream of money directed to intermediate products which will be roughly as many times greater than the stream of money directed against consumption goods as the average number of periods of time which elapse between the application of the original factors of production and the completion of the consumption goods. (I apologise for this terrible ‘German’ sentence.) The proportion between the demand for consumption goods and the demand for intermediate products will however exactly correspond to the average length of the production process only on the assumption that the goods pass from one stage to the next in equal intervals corresponding to the unit period. What it will actually be depends upon the given organisation of industry, but given this organisation it will change with every change in the amount of capital existing—or, what means the same thing, the average length of the production period—and will remain different so long as the amount of capital remains at its new level (and not only so long as the amount of capital is changing).

The situation is not fundamentally different if we take the other ideal case where the existence of capital is entirely due to the other of the two causes, the durability of the instruments. If we assume that the actual process of production of the instruments as well as of the finished consumption goods takes no appreciable time so that only ‘fixed’ capital and no 'circulating' capital is existing, then it is again clear that, in order to maintain capital constant, such proportion of the existing machinery as wears out during a period will have to be replaced. In a stationary society this proportion will be determined by the amount of capital and its lifetime, and since the amount of capital existing at a moment of time will itself of necessity be equal to the discounted value of a year’s output of consumers’ goods times the average lifetime of the machines, the annual demand for machines will stand in a proportion to the annual output of consumers’ goods which is determined by the average duration of the machines.

The problem becomes, of course, a little more complicated if one combines, as one has to do to come nearer to reality, the two factors determining the existence of capital. The simplest way out seems to me to be to reduce both factors, ‘duration of the process’ in the narrower sense and the duration of the instruments, to the concept of the average length of the production process in a wider sense as the common denominator. I am conscious that I have treated the durability factor lightly too in Prices and Production, but I did so because I hoped to make it less difficult and because I assumed a greater familiarity with Bohm-Bawerk’s concepts of the average length of production than I ought obviously have done. I have, however, treated these problems at somewhat greater length in sections IX–XI of my ‘Paradox of Saving’.

Yours very truly,
F. A. HAYEK
(Moggridge 1973: 260–262).

These letters concern Hayek’s assumptions about the nature of capital goods in Prices and Production.

Repapis (2011: 721) argues that Prices and Production contains a serious oversimplification: that capital depreciates entirely after becoming productive – or all capital is circulating capital and fixed capital is ignored.

That assumption about real world capitalist economies is unrealistic, and Hayek admitted as much in these words in his letter to Keynes:

“The problem becomes, of course, a little more complicated if one combines, as one has to do to come nearer to reality, the two factors determining the existence of capital. The simplest way out seems to me to be to reduce both factors, ‘duration of the process’ in the narrower sense and the duration of the instruments, to the concept of the average length of the production process in a wider sense as the common denominator. I am conscious that I have treated the durability factor lightly too in Prices and Production, but I did so because I hoped to make it less difficult and because I assumed a greater familiarity with Bohm-Bawerk’s concepts of the average length of production than I ought obviously have done.”

But heterogeneous capital can also have a significant degree of durability and substitutability. A capital structure in a capitalist economy where we find some important degree of adaptability, versatility and durability in the nature of capital goods means that the Austrian business cycle theory of Hayek, as propounded in Prices and Production, is not a realistic vision of modern economies.

George L. S. Shackle also pointed to this problem in Hayek’s business cycle theory:

“Hayek’s argument, viewing ‘capital goods’ as materials which only retain their physical identity through a process of fabrication into consumable form, overlooks the grip that durability has in constraining the business man’s choice of productive methods. The span of the nine-year business cycle, to which his theory was meant to apply, is not long enough for a wholesale discarding of existing equipment during the latter half of its upward phase, say two or three years.” (Shackle 1981: 240).

All in all, this problem with capital theory is yet another flaw in Hayek’s theory of economic cycles.

Sunday, October 14, 2012

I have not read Keynes’s A Tract on Monetary Reform (1923) in a while, but I was struck by the following passage on a recent re-reading of the work. This is Keynes arguing against post-war deflation in Europe after the First World War:

“In the first place, Deflation is not desirable, because it effects, what is always harmful, a change in the existing Standard of Value, and redistributes wealth in a manner injurious, at the same time, to business and to social stability. Deflation, as we have already seen, involves a transference of wealth from the rest of the community to the rentier class and to all holders of titles to money; just as inflation involves the opposite. In particular it involves a transference from all borrowers, that is to say from traders, manufacturers, and farmers, to lenders, from the active to the inactive.

But whilst the oppression of the taxpayer for the enrichment of the rentier is the chief lasting result, there is another, more violent, disturbance during the period of transition. The policy of gradually raising the value of a country’s money to (say) 100 per cent above its present value in terms of goods … amounts to giving notice to every merchant and every manufacturer, that for some time to come his stock and his raw materials will steadily depreciate on his hands, and to every one who finances his business with borrowed money that he will, sooner or later, lose 100 per cent on his liabilities (since he will have to pay back in terms of commodities twice as much as he has borrowed). Modern business, being carried on largely with borrowed money, must necessarily be brought to a standstill by such a process. It will be to the interest of everyone in business to go out of business for the time being; and of everyone who is contemplating expenditure to postpone his orders so long as he can. The wise man will be he who turns his assets into cash, withdraws from the risks and the exertions of activity, and awaits in country retirement the steady appreciation promised him in the value of his cash. A probable expectation of Deflation is bad enough; a certain expectation is disastrous. For the mechanism of the modern business world is even less adapted to fluctuations in the value of money upwards than it is to fluctuations downwards.” (Keynes 1923: 143–144).

Keynes, then, was well aware of the debt deflationary effects of price deflation from early in his career, and the way in which price deflation penalises businesses that have borrowed money.

Thursday, October 11, 2012

There is arguably a split in Austrian economics on the issue of equilibrium (Vaughn 1994: 162). Lewin (1999: 27) speaks of a “rift within the subjectivist Austrian family” on the issue of a tendency to equilibrium.

On the one hand, the early Hayek, Mises, Kirzner, and Rothbard see markets as having a real tendency to equilibrium states (whether defined as some Walrasian general equilibrium state in Hayek’s pre-1937 work, Hayek’s “plan coordination” after 1937, Mises’s “final state of rest”, or Rothbard’s evenly rotating economy [ERE]).

From 1937, Hayek redefined equilibrium from the notion of a set of market clearing prices to the new concept of “plan coordination,” a situation where individual plans are coordinated (Vaughn 1994: 169). This state of affairs means that an economy might be on a path toward a type of equilibrium without all markets having to clear (Vaughn 1994: 169). Hayek’s notion of plan coordination was taken up and used by Kirzner, Lavoie, Garrison and other later Austrians (Vaughn 1994: 169; O’Driscoll and Rizzo 1996: 80). Indeed, according to Charles W. Baird (1987: 197), “Hayekian equilibrium” or “plan coordination” is “the notion that most Austrians consider useful.”

And one can’t help but notice that, in Hayek’s later statements and thought, he does not entirely dispense with the idea of market clearing equilibrium prices as an explanation of unemployment either. In a talk to the American Enterprise Institute in Washington DC on April 9, 1975 Hayek sounds like a neoclassical:

“These discrepancies of demand and supply in different industries, discrepancies between the distribution of demand and the allocation of the factors of production, are in the last analysis due to some distortion in the price system that has directed resources to false uses. It can be corrected only by making sure, first, that prices achieve what, somewhat misleadingly, we call an equilibrium structure, and second, that labor is reallocated according to these new prices.

Lacking such price readjustment and resource reallocation, the original unemployment may then spread by means of the mechanism I have discussed before, the “secondary contraction,” as I used to call it. In this way, unemployment may eventually become general.

The primary cause of the appearance of extensive unemployment, however, is a deviation of the actual structure of prices and wages from its equilibrium structure. Remember, please: that is the crucial concept. The point I want to make is that this equilibrium structure of prices is something which we cannot know beforehand because the only way to discover it is to give the market free play; by definition, therefore, the divergence of actual prices from the equilibrium structure is something that can never be statistically measured.” (Hayek 1975: 6–7).

This demonstrates that, despite his 1937 notion of “plan coordination,” Hayek was still capable of reverting to neoclassical equilibrium ideas as late as 1975.

The stream of Austrian economics that asserts the idea of a tendency to equilibrium may well be more a supplement to neoclassical economics than a replacement (Vaughn 1994: 166). For example, Kirzner’s entrepreneurial theory is one method by which Austrians can posit a real world tendency to market coordination.

Occupying an intermediate position are Rizzo and O’Driscoll. They rejected even Hayek’s “plan coordination” idea (which they saw as just another type of static equilibrium concept: O’Driscoll and Rizzo 1996: 80–82). Instead, Rizzo and O’Driscoll argue that markets have a tendency to “pattern coordination,” a weaker concept of economic coordination which consists merely of some degree of order in which individual actions “are coordinated with respect to their typical features, even if their unique aspects fail to mesh” (O’Driscoll and Rizzo 1996: 85).

On the other side of the Austrian school are Ludwig Lachmann and those influenced by him. Vaughn argues that Lachmann thought that markets are subject to both disequilibrating and equilibrating tendencies, but took no position on exactly what tendency dominates the market system (Vaughn 1994: 160; see also Prychitko 1993: 375). Prychitko holds that there is no a priori basis on which to assert that markets tend to equilibrium states (Prychitko 1993: 375).

Whether there is an inherent tendency to disequilibrium is a different question, of course.

Even a Post Keynesian economist like Paul Davidson does not argue that free market economies are inherently disequilibrating (Davidson 1993: 436). Rather, Post Keynesians argue that there is nothing in market systems that ensure that the economy will converge automatically to full employment equilibrium (Davidson 1993: 436). For Keynes, the most serious flaws in capitalism were as follows:

“The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes.” (Keynes 1936: 372).

BIBLIOGRAPHY

Baird, Charles W. 1987. “The Economics of Time and Ignorance: A Review,” The Review of Austrian Economics 1.1: 189–206.

“Keynes spared his readers, even in the deliberately provocative General Theory of 1936, the ultimate force of his conclusion, that rational conduct is an illusion and unrelated to the realities of business. That final smashing of the idol was reserved for his last version of the theory of unemployment, the Quarterly Journal reply to his critics. He nowhere speaks, I believe, of ‘rational conduct’ in those terms. His summary statement, uttered in speech, was ‘Equilibrium is blither.’” (Shackle 1972: 233; see also Shackle 1974: 39).

I am not sure, however, who or what work is the ultimate source for this “equilibrium is blither” saying.

Wednesday, October 10, 2012

C. Repapis has the following critical article on Hayek’s Austrian business cycle theory (ABCT):

Repapis, Constatinos. 2011. “Hayek’s Business Cycle Theory during the 1930s: A Critical Account of its Development,” History of Political Economy 43: 699–742.

I provide a summary below, and my own thoughts on the Hayekian ABCT.

I will divide the discussion into two sections: problems with Hayek’s use of (1) general equilibrium theory and the role of expectations, and (2) Austrian capital theory.

I. General Equilibrium Theory and Expectations
Repapis notes that Hayek used general equilibrium theory as the fundamental theoretical framework for his business cycle research (Repapis 2011: 702–703).

Hayek is quite clear that a tendency to general equilibrium in the real world is an assumption of his work:

“… it is my conviction that if we want to explain economic phenomena at all, we have no means available but to build on the foundations given by the concept of a tendency toward an equilibrium. For it is this concept alone which permits us to explain fundamental phenomena like the determination of prices or incomes, an understanding of which is essential to any explanation of fluctuation of production. If we are to proceed systematically, therefore, we must start with a situation which is already sufficiently explained by the general body of economic theory. And the only situation which satisfies this criterion is the situation in which all available resources are employed.” (Hayek 2008: 34–35).

Yet the existence of equilibrium is “not an empirically relevant state of affairs” (Repapis 2011: 703). The idea of equilibrium and a tendency to equilibrium requires that agents have expectations that are fulfilled and nothing is unforeseen (Repapis 2011: 703–704). That is to say, the agents in Hayek’s model of the cycle live in a world of “certain outcomes” (Repapis 2011: 713). But obviously this ignores the reality of fundamental uncertainty in the world and economic life.

Karl Gunnar Myrdal (1898–1987) had already criticised Hayek’s ABCT by drawing attention to the problematic role of expectations in a 1933 paper (Myrdal 1933: 385; Repapis 2011: 713). Importantly, the problematic role of expectations for Hayek’s trade cycle theory was also being raised within the Austrian school in the 1930s, as Ludwig Lachmann related in an Austrian Economics Newsletter (AEN) interview:

“AEN: You have talked a number of times about the importance of expectations in business cycle theory. What first drew your interest to expectations as far as the business cycle question was concerned.

Therefore the expectations of entrepreneurs in disequilibrium (always the real state of the economy) do not in reality work in the way Hayek required in his theory.

Although Hayek came to realise that his use of general equilibrium theory and assumptions about expectations were unsatisfactory, nevertheless even in Profits, Interest and Investment (1939) he had still not properly addressed these criticisms or modified his trade cycle theory to deal with them, a charge later levelled against him by G. L. S. Shackle (Repapis 2011: 716; see Shackle in O’Brien and Presley 1981: 241).

To return to the general question of general equilibrium theory, if this theory is false and the assumption of a market tendency to equilibrium is not a description of the real world, as Post Keynesians and even some Austrians in the tradition of Ludwig Lachmann argue, then it follows that the ABCT cannot be considered an accurate theory of actual business cycles. It is a further shortcoming of Austrian economics that certain Austrians can deny the usefulness or truth of general equilibrium theory but continue to use the ABCT (I am thinking of Austrians influenced by Lachmann and even Rizzo and O’Driscoll).

The use of general equilibrium theory by Hayek as the foundation of his business cycle research already throws up insuperable problems for the ABCT.

Repapis (2011: 717) contends that by the time of Hayek’s book The Pure Theory of Capital (1941) his analysis and understanding of equilibrium was far from the way he had defined it in Prices and Production, so that his business cycle theory now needed to be thoroughly revised. But Hayek never did this.

I would conclude that this is why it is perfectly legitimate to say that Hayek’s business cycle theory was ultimately a failure, a view essentially also taken by Witt (1997: 46–48) and Caldwell (2004: 228).

II. Austrian Capital Theory
Another problem with the ABCT is certain aspects of its capital theory. As is well known, Austrian capital theory categorises capital goods into higher or lower orders, as removed from the final consumption goods. But the notion that every capital good can be classified into such a higher or lower class is open to question (Repapis 2011: 706, n. 15; Marshall 1961 [1890]: 64–65, n. 3).

Repapis points to another problem with Hayek’s capital theory as assumed in Prices and Production:

“… [sc. there is] a central simplification in Hayek’s capital structure in Prices and Production. This is that capital depreciates completely once it becomes productive, or to put it another way, all capital is ‘circulating’ capital and there is no discussion of ‘fixed’ capital. However, this is a highly unrealistic assumption and Hayek knew it. In a letter to Keynes on 7 January 1932 he writes that ‘I am conscious that I have treated the durability factor lightly too in Prices and Production, but I did so because I hoped to make it less difficult and because I assumed a greater familiarity with Böhm-Bawerk’s concept of the average length of production than I ought obviously have done’ (Keynes 1987, 262). In the same letter he distinguished between two different ways to represent the capital process: one is on the ‘duration of the process of production,’ which is what Prices and Production was based on; the other is on the ‘durability of many instruments of production,’ which his analysis so far ignored. He concludes that ‘the problem becomes, of course, a little more complicated if one combines, as one has to do to come nearer to reality, the two factors determining the existence of capital’.” (Repapis 2011: 720–721).

In the real world, capital is heterogeneous, but also has a degree of durability and substitutability.

While the neoclassical view of capital as homogenous (or as a sort of transformable putty) is wrong, just because capital is heterogeneous and sometimes non-substitutable, it does not mean all throughout the economy one will also find quite durable, adaptable and substitutable capital goods.

Repapis draws the following conclusions:

“Where does this leave Hayek’s business cycle theory? Whereas one of Hayek’s most insightful critiques of contemporary business cycle theories was that they regarded capital as an absolute ‘datum’ that is given for short-period analysis, and therefore capital theory was separated from business cycle theory, he finds his theory occupying the opposite extreme, one in which capital is a flow, and has nothing to say about the changing uses of fixed capital. However, the changing use, and future use, of durable goods in the business cycle is a central preoccupation of the capitalist and cannot be ignored in any theory of the cycle. As G. L. S. Shackle (1981, 240) writes, ‘Hayek’s argument, viewing “capital goods” as materials which only retain their physical identity through a process of fabrication into consumable form, overlooks the grip that durability has in constraining the business man’s choice of productive methods.’” (Repapis 2011: 723).

“Hayek considers capital a fragile, perishable good, constructed for a particular purpose whose value substantially diminishes once its specific usefulness is surpassed. Minor changes in the interest rate or changes in demand may lay waste machines built over time and dearly paid for.” (Repapis 2011: 724).

“In the other extreme, Hayek underplays the malleability of existing capital and its ability to be transformed into something profitable if the economic conditions of the cycle so demand. His insistence that investment must start again almost from scratch is an extreme position, but again it underlines what other contemporary theories of the 1930s underplay, the real loss of capital in the cycle due to unforeseen demand changes.” (Repapis 2011: 725).

No doubt there is a real loss of capital when demand changes or the interest rate rises, but is it as catastrophic and sweeping as imagined in the ABCT? Hardly. The capital structure also has a degree of adaptability, versatility and durability that means that the Austrian policy prescription of liquidationism in a recession does not logically follow either.

These problems with the Austrian capital theory and its assumptions underlying Prices and Production are yet another severe blow to the ABCT.

The criticisms of Austrian capital theory as raised by Repapis also mirror the comments of David Ramsay Steele (as quoted on Robert Murphy’s blog). I end by reproducing his remarks:

“The distinctive thing about Austrian trade cycle theory is its view of ‘real’ factors in the onset of the slump. Of course, much of what Mises and Hayek say overlaps with the ‘purely monetary’ theories of people like Milton Friedman, and long before that, of people like Hawtrey. So there is no dispute that inflation of credit may create a phoney boom, followed by an uncomfortable period of adjustment. What is distinctive about the Austrian theory is that it says the specific physical form of the capital which is malinvested plays a crucial role in the onset of the slump. So, for example, if lengthening the production structure requires a particular type of big, expensive machine that has no use with a shorter production structure, then that machine will have to be written off as a loss, since it is not suitable to the ‘return to reality’ when the boom is over.

What struck me very early about this (I think it crossed my mind when I read Rothbard’s book on the 1930s depression, around 1971) was that it’s an empirical claim, and at a quick glance, such physical incongruities don’t seem to loom all that large. So, if the production structure lengthens, you change the shape of investment into something more appropriate to a lower time-preference. Fair enough. But what does this really mean? Let’s say you have a factory. You start to use different types of machine tools, let’s say. Still, most of your factors will be just the same, or almost the same, as before: electricity, computers (or in the old days, office stationery), unskilled workers, workers with various types of skill such as accountants, engineers, salespeople, and managers, your factory building itself, your use of trucks to get materials into the factory and products out, and so on. In other words, the overwhelming majority of the factors you employ are not specific to higher or lower orders of production. It’s true that their application to specific tasks will shift a bit, but this goes on all the time, and is an inexact science at best.

Since the claim that physical incongruities are crucial is an empirical claim, I was then struck by the experience of the US at the end of World War II. If ever there was a case of an abrupt, almost overnight, mismatch between prior allocations of capital and today’s applications, we could hardly imagine a more spectacular example. Millions of people left the army and found civilian work. Hundreds of thousands of factories which had been producing military goods had to transform their operations into civilian production. Why was the whole system not seized by a violent slump?

To the purely monetary approach, this is simple and obvious. There was no violent contraction of the money supply, so there was no slump. But to the Austrians, what explanation could there possibly be? Their claim is that once the boom has got going it cannot be ended without a slump, and that this is so because of the need to suddenly re-allocate physical assets to completely new uses. But that re-allocation was obviously thousands of times greater in 1945 than it could ever be as the result of a few years of bank credit expansion, and yet there was no slump! The whole system adapted to the utterly changed conditions with amazing ease and smoothness. ….http://consultingbyrpm.com/blog/2012/05/federal-government-outlays-and-receipts-as-of-nominal-gdp.html#comment-39021

Repapis, Constatinos. 2011. “Hayek’s Business Cycle Theory during the 1930s: A Critical Account of its Development,” History of Political Economy 43: 699–742.

The first two criticise Mises’s business cycle theory from the perspective of neoclassical economics, so do not interest me as much as the third. The second is also a revised version of the first.

The third paper is a critical survey of Hayek’s trade cycle theory in the 1930s, including some useful criticisms of Hayek’s assumptions about capital goods, and is of much greater interest to me than the first two. I will have more to say about the third article in future posts.

Below is a link to an audio interview by Russ Roberts with Robert Skidelsky. The discussion partly deals with the new book How Much is Enough: Money and the Good Life by Robert Skidelsky and Edward Skidelsky:

A short, but nice little summary of the nature and origin of money, by Tony Greenham and Josh Ryan-Collins, authors of Where Does Money Come From?: A Guide to the UK Monetary and Banking System (2011). You can also read a summary here.

BIBLIOGRAPHY

Ryan-Collins, Josh, Greenham, Tony and Richard Werner. 2011. Where Does Money Come From?: A Guide to the UK Monetary and Banking System. New Economics Foundation.